Chapter 1
The nature of cost and managerial accounting
Nature and Scope of Cost Accounting
In the modern business world, the nature and functioning of business
organisations have become very complicated. They have to serve the needs of
variety of parties who are interested in the functioning of the business. These
parties constitute the owners, creditors, employees, government agencies, tax
authorities, prospective investors, and last but not the least the management
of the business. The business has to serve the needs of these different
categories of people by way of supplying various information from time to
time. In order to satisfy the needs of all these group of people a sound
organisation of accounting system is very essential. In the ancient days the
information required by those who were interested with a business
organisation was met by practising a system of accounting known as financial
accounting system. Financial accounting is mainly concerned with preparation
of two important statements, viz., income statement (or profit and loss
account) and positional statement (or Balance Sheet). This information served
the needs of all those who are not directly associated with management of
business. Thus financial accounting is concerned with external reporting as it
provides information to external authorities. But management of every
business organisation is interested to know much more than the usual
information supplied to outsiders. In order to carry out its functions of
planning, decision-making and control, it requires additional cost data. The
financial accounting to some extent fails to provide required cost data to
management and hence a new system of accounting which could provide
internal report to management was conceived of.
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Q.1. Name the parties interested in the functioning of the business.
Ans.1. These parties constitute the owners, creditors, employees, government
agencies, tax authorities, prospective investors, and last but not the least the
management of the business.
Q.2. Which accounting in the ancient days information required by interested
parties was met?
Ans.2. In the ancient days the information required by those who were
interested with a business organisation was met by financial accounting.
Q.3. Financial Accounting is mainly concerned with preparation of
_____________________________ and _______________________________.
Ans.3. Income statement (Profit and Loss Account)
Positional statement (Balance Sheet)
Q.4. The Financial Accounting to some extent __________ to provide required
cost data to management.
Ans.4. Fails
Q.5. Financial Accounting is concerned with __________ reporting as it
provides information to __________ authorities.
Ans.5. External
External
Q.6. Financial Accounting serves the need of all those parties who are not
directly associated with management of business. (True)
Q.7. A new system of accounting which could provide internal report to
management was conceived of. (True)
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NEED FOR COST ACCOUNTING
The need for cost accounting arises owing to the following:
To Overcome the Limitations of Financial Accounting
Financial accounting records in an overall manner the results of the operations
of a business, using conventional double entry book-keeping techniques. It
suffers from the following limitations:
(i) It provides only past data: Financial accounting provide out of date
information to management. But management is interested in current data but
not past data as it does not serve any purpose to it.
(ii) It reveals only overall result of the business: Financial accounting does not
provide data for each and every product, process, department or operation
separately. Instead it provides the financial information in a summary form for
the entire organization as a whole.
(iii) It is static in nature: Modern business is dynamic but not static. Financial
accounting does not incorporate the changes that take place within the
business.
(iv) It fails to take into account the impact of price level change: In the
modern inflationary conditions the price level has significant impact over
financial statement. Under financial accounting, assets are shown at the actual
or historical cost. Consequently depreciation is also charged on actual or
historical cost. This under charging of depreciation will distort the profit figure.
(v) Possibility of manipulation of financial accounting: Very often financial
accounting is manipulated at the whims and fancies of management so as to
project better image in the minds of prospective investors. The chief forms of
manipulating the financial accounting assume the form of over or
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undervaluation of inventory, excessive or inadequate provision for
depreciation, creation of secret reserves, etc.
(vi) It fails to exercise control over resources: Financial accounting fail to
exercise control over materials, labour and other expenses incurred in a
business enterprise. As a result, avoidable wastages and losses go unchecked
under this system of accounting.
(vii) It fails to provide adequate data for price fixation: Financial accounting
fail to provide adequate cost data on the basis of which selling price is fixed. In
the absence of fixation of prices in advance, it is not possible to supply
quotations to the prospective customers.
(viii) It fails to provide adequate data for management in carrying out its
functions: Management of every organization relies heavily on adequate cost
data for formulating policies and in decision-making process. But financial
accounting fails to provide such useful cost data to management.
(ix) It does not provide a basis for cost comparison: Financial accounting does
not help in cost comparison over a period of time or between two jobs or two
operations. Thus a basis for judging the efficiency of a year with past year or
worthfulness of two different jobs or operations cannot be appraised.
(x) It does not make use of control techniques: Financial accounting fail to
make use of certain important cost control techniques such as budgetary
control and standard costing. Thus financial accounting does not facilitate
measuring the efficiency of the business with the help of control techniques.
(xi) It fails to ascertain break-even point: Financial accounting does not help
in ascertaining the break-even point, i.e., the sale or output where the revenue
equals the cost. Hence, the point of no-profit-no-loss cannot be made out
under financial accounting.
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To Ensure Optimum Utilisation of Resources
In today’s business world, the resources available are very scarce. Hence every
business unit must strive hard to obtain maximum output with the available
input. In order to ensure the optimum utilization of scarce resources, the value
of input is measured against the value of output. This implies matching cost
per unit of production against the value of output or selling price. But financial
accounting does not provide the information relating to cost per unit of
production. Hence the need for cost accounting was felt necessary.
To Achieve Overall Efficiency of Business
Every businessman will make constant effort to improve his business. In order
to formulate suitable policy and sound decision, he has to know answers to
certain questions such as (a) What is the maximum profit which a business can
make. (b) Is the profit earned by it is more or less compared to the earlier
years? (c) Which product line is making more profit? (d) Has too much capital is
blocked in raw materials? (e) Whether the cost of production has gone up
compared to earlier years? (f) Should the selling price require revision? Cost
accounting serves as a useful tool in the hands of management in this
direction. By analysing the cost of production of every unit, it helps
management to know the answers to the above questions.
Q.8. Why did the need for Cost Accounting arise?
Ans.8. The need for cost accounting arose owing to the following:
(i) To Overcome the Limitations of Financial Accounting
(ii)To Ensure Optimum Utilisation of Resources
(iii)To Achieve Overall Efficiency of Business
Q.9. What are the limitations of Financial Accounting?
Ans.9. Financial Accounting suffers from the following limitations:
(i) It provides only past data
(ii) It reveals only overall result of the business
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(iii) It is static in nature
(iv)It fails to take into account the impact of price level change
(v) Possibility of manipulation of financial accounting
(vi)It fails to exercise control over resources
(vii) It fails to provide adequate data for price fixation
(viii) It fails to provide adequate data for management in carrying out its
functions
(ix) It does not provide a basis for cost comparison
(x) It does not make use of control techniques
(xi) It fails to ascertain break-even point
Q.10. Financial accounting provides only past data. (True)
Q.11. Financial accounting reveals only overall result of the business. (True)
Q.12. Financial accounting is dynamic in nature. (False)
Ans.12. Financial accounting is static in nature.
Q.13. Financial accounting takes into account the impact of price level change.
(False)
Ans.13. Financial accounting fails to take into account the impact of price level
change.
Q.14. Financial accounting is manipulated at the whims and fancies of
management so as to project better image in the minds of prospective
investors. (True)
Q.15. Financial accounting keeps control over resources. (False)
Ans.15. Financial accounting fails to exercise control over resource.
Q.16. Financial accounting provides adequate data for price fixation. (False)
Ans.16.Financial accounting fails to provide adequate data for price fixation.
Q.17. Financial accounting fails to provide adequate data for management in
carrying out its functions. (True)
Q.18. Financial accounting provides a basis for cost comparison. (False)
Ans.18.Financial accounting does not provide a basis for cost comparison.
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Q.19. Financial accounting does not make use of control techniques. (True)
Q.20. Financial accounting ascertains break-even point. (False)
Ans.20.Financial accounting fails to ascertain break-even point.
Q.21. In today’s business world, the resources available are very________.
Ans.21. scarce
Q.22.Every business unit must strive hard to obtain __________ output with
the available input.
Ans.22. Maximum
Q.23.In order to ensure the optimum utilization of ________ resources, the
value of input is measured against the value of output.
Ans.23. Scarce
Q.24. Financial accounting does not provide the _________ relating to cost per
unit of production.
Ans.24. Information
Q.25.Every businessman makes _________ effort to improve his business.
Ans.25. Constant
Q.26.In order to formulate suitable policy and sound decision, every
businessman has to know __________ to certain questions.
Ans.26. Answers
DEFINITION AND SCOPE OF COST ACCOUNTANCY
The terminology of cost accountancy published by the Institute of Cost and
Management Accountants, London defines cost accountancy as “the
application of costing and cost accounting principles, methods and techniques
to the science, art and practice of cost control and the ascertainment of
profitability. It includes the presentation of information derived the reform for
the managerial decision-making.”
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On analysis of the above definition, the following features of cost accountancy
become evident:
(a) “Cost accountancy” is used in the broadest sense when compared to “cost
accounting” and “costing”. This is so because cost accountancy is concerned
with the formulation of principles, methods and techniques to be applied for
ascertaining cost and profit.
(b) Having ascertained ‘cost’ and ‘profit’, cost accountancy is concerned with
presentation of information to management. To enable management to carry
out its functions, reports must be promptly made available at the right time, to
the right person and in a proper form.
(c) The information so provided is to serve the purpose of managerial decisionmaking such as introducing a new line of product, replacement of manual
labour by machines, make or buy decisions, etc.
Q.27. What is the definition of Cost accounting?
Ans.27. “The application of costing and cost accounting principles, methods
and techniques to the science, art and practice of cost control and the
ascertainment of profitability. It includes the presentation of information
derived the reform for the managerial decision-making.”
Q.28. “Cost accountancy” is used in the broadest sense when compared to
“cost accounting” and “costing”. (True)
Q.29. Cost accountancy is not concerned with the formulation of principles,
methods and techniques to be applied for ascertaining cost and profit. (False)
Ans.29. Cost accountancy is concerned with the formulation of principles,
methods and techniques to be applied for ascertaining cost and profit.
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SCOPE OF COST ACCOUNTANCY
The scope of any subject refers to the various areas of study included in that
subject. As regards the scope of cost accountancy is concerned, it has vast
scope. The following topics fall under the purview of cost accountancy:
(1) Costing, (2) Cost Accounting, (3) Cost Control Techniques, (4) Budgeting and
(5) Cost Audit.
1. Costing
The terminology of ICMA, London, defines costing as “the technique and
process of ascertaining the cost.” According to the revised terminology of
ICMA, London, “Costing is the process of determining the costs of products,
services or activities.”
The above definition is very significant in as much as it carries the main theme
of cost accountancy. This definition emphasizes two important aspects, viz.
(a) The technique and process of costing: The technique of costing involves
two distinct steps, namely, (i) collection and classification of costs according to
various elements and (ii) allocation and apportionment of the expenses which
cannot be directly charged to production. As a process, costing is concerned
with the routine ascertainment of cost with a formal procedure.
(b) Ascertainment of cost: It involves three steps, viz. (i) collection and
analysis of expenses, (ii) measurement of production at different stages and
(iii) linking up of production with the expenses. To achieve the first step,
costing has developed different systems such as Historical, Estimated and
Standard Cost. For achieving the second step, costing has developed different
methods such as single or output costing. Job costing, contract costing, etc.
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Finally, for achieving the last step costing has developed important techniques
such as Absorption Costing, Marginal Costing and Standard Costing.
2. Cost Accounting
Kohler in his dictionary for Accountants defines cost accounting as “that
branch of accounting dealing with the classification, recording, allocation,
summarization and reporting of current and prospective costs.” Mr. Wheldon
defines cost accounting as “the classifying, recording and appropriate
allocation of expenditure for the determination of the costs of products or
services, the relation of these costs to sales values, and the ascertainment of
profitability.”
The above definitions reveal the following aspects of cost accounting:
(a) Cost classification: This refers to grouping of like items of cost into a
common group.
(b) Cost recording: This refers to posting of cost transactions into the various
ledgers maintained under cost accounting system.
(c) Cost allocation: This refers to allotment of costs to various products or
department.
(d) Cost determination or cost finding: This refers to the determination of the
cost of goods or services by informal procedure, i.e., procedures that do not
carry on the regular process of cost accounting on a continuous basis.
(e) Cost reporting: This refers to furnishing of cost data on a regular basis so as
to meet the requirements of management.
Q.30. Scope of any subject refers to the various areas of study included in that
subject. (True)
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Q.31. As regards the scope of cost accountancy is concerned, it has____ scope.
Ans.31. Vast
Q.32. What is the definition of Costing?
Ans.32. “Costing is the process of determining the costs of products, services
or activities.”
Q.33. Write down the definition of Cost accounting?
Ans.33. Cost accounting is “that branch of accounting dealing with the
classification, recording, allocation, summarization and reporting of current
and prospective costs.”
Q.34. Differentiate between Cost Accountancy, Costing and Cost Accounting.
Ans.34. Difference between Cost Accountancy, Costing and Cost Accounting
Points of
Differences
Cost Accountancy
Costing
1. Scope
Cost accountancy is It is broader in its
broadest in its scope. scope.
2. Function
It is concerned with It is concerned with
formulation of costing ascertainment
of
principles,
methods cost.
and techniques to be
adopted by a business.
3. Periodicity of It is a starting point.
It begins where
Functioning
accountancy ends
cost.
4. Persons
The persons involved The person involved
Involved
are experts in the field is cost accountant.
of cost accountancy
such as management
accountant.
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Cost Accounting
It is narrow in
its scope.
It is concerned
with recording
of cost.
It begins where
costing ends.
The
persons
involved
are
cost clerks.
3. Cost Control
According to Kohler, cost control represents the employment of management
devices in the performance of any necessary operation so that pre-established
objectives of quality, quantity and time may be attained at the lowest possible
outlay for goods and services. The terminology published by ICMA, London,
defines cost control as “The guidance and regulation by executive action of the
cost of operating an undertaking.” According to this definition, cost control
aims at guiding the actual towards the lines of target and regulates the actual if
they deviate from the targets. This process will become clear by enumerating
the steps involved in any cost control technique.
(a) Fixation of targets in terms of cost and production performance.
(b) Ascertaining the actual cost and production performance.
(c) Comparison of actual with the targets.
(d) Analysing the variance by causes and the person responsible for it.
(e) Taking remedial steps to set right unfavourable variations.
Cost control is exercised through a variety of techniques such as inventory
control, quality control, budgetary control, standard costing, etc. The
advantages of cost control are as follows:
(a) It helps in utilizing the resources to the full extent.
(b) It helps in reduction of prices which are benefited by customers.
(c) It helps in competing successfully in the market.
(d) It increases the profit earning capacity of the business.
(e) It increases the goodwill of the business.
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Q.35. What are the steps in a cost control technique?
Ans.35. Followings are the steps involved in a cost control technique.
(a) Fixation of targets in terms of cost and production performance.
(b) Ascertaining the actual cost and production performance.
(c) Comparison of actual with the targets.
(d) Analysing the variance by causes and the person responsible for it.
(e) Taking remedial steps to set right unfavourable variations.
Q.36. What are the advantages of cost control?
Ans.36. The advantages of cost control are as follows:
(a) It helps in utilizing the resources to the full extent.
(b) It helps in reduction of prices which are benefited by customers.
(c) It helps in competing successfully in the market.
(d) It increases the profit earning capacity of the business.
(e) It increases the goodwill of the business.
4. Budgeting
Mr. Heiser in his book Budgeting—Principles and Practice, defines budget as
“an overall blue print of a comprehensive plan of operations and actions
expressed in financial terms. According to him budgeting process involves the
preparation of a budget and its fullest use not only as a devise for planning and
co-ordinating but also for control.”
5. Cost Audit
The terminology of ICMA, London, defines cost audit, as “the verification of the
correctness of cost accounts and of the adherence to the cost accounting
plan.”
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Q.37. What do you mean by cost audit?
Ans.37. Cost audit mean “the verification of the correctness of cost accounts
and of the adherence to the cost accounting plan.”
NATURE OF COST ACCOUNTING
The nature of cost accounting can be brought out under the following
headings:
1. Cost accounting is a branch of knowledge: Though considered as a branch
of financial accounting, cost accounting is one of the important branches of
knowledge, i.e., a discipline by itself. It is an organised body of knowledge
consisting of its own principles, concepts and conventions. These principles
and rules vary from industry to industry.
2. Cost accounting is a science: Cost accounting is a science as it is a body of
systematic knowledge relating to not only cost accounting but relating to a
wide variety of subjects such as law, office practice and procedure, data
processing, production and material control, etc. But it is to be admitted that it
is not a perfect science as in the case of natural science.
3. Cost accounting is an art: Cost accounting is an art in the sense it requires
the ability and skill on the part of cost accountant in applying the principles,
methods and techniques of cost accountancy to various management
problems. These problems include the ascertainment of cost, control of costs,
ascertainment of profitability, etc.
4. Cost accounting is a profession: In recent years cost accounting has become
one of the important professions which have become more challenging. This
view is evident from two facts. First, the setting up of various professional
bodies such as National Association of Accountants (NAA) in USA. The Institute
of Cost and Management Accountants in UK, the Institute of Cost and Works
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Accountants in India and such other professional bodies both in developed and
developing countries have increased the growing awareness of costing
profession among the people. Secondly, a large number of students have
enrolled in these institutes to obtain costing certificates and memberships for
earning their livelihood.
Q.38. Though considered as a branch of financial accounting, cost accounting is
one of the important branches of knowledge. (True)
Q.39. Cost accounting is a science as it is a body of systematic knowledge
relating to not only cost accounting but relating to a wide variety of subjects.
(True)
Q.40. Cost accounting is an art in the sense it requires the ability and skill on
the part of cost accountant in applying the principles, methods and techniques
of cost accountancy to various management problems. (True)
MANAGEMENT ACCOUNTING AN INTRODUCTION
Management accounting can be viewed as Management-oriented Accounting.
Basically it is the study of managerial aspect of financial accounting,
"accounting in relation to management function".
It shows how the
accounting function can be re-oriented so as to fit it within the framework of
management activity.
The primary task of management accounting is,
therefore, to redesign the entire accounting system so that it may serve the
operational needs of the firm. If furnishes definite accounting information,
past, present or future, which may be used as a basis for management action.
The financial data are so devised and systematically developed that they
become a unique tool for management decision.
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Q.41. What is the primary task of Management Accounting?
Ans.41.The primary task of management accounting is, therefore, to redesign
the entire accounting system so that it may serve the operational needs of the
firm.
Q.42. What does Management Accounting furnish to the management?
Ans.42. Management Accounting furnishes definite accounting information,
past, present or future, which may be used as a basis for management action.
Q.43. The financial data are so devised and ____________ developed that they
become a _________ tool for management decision.
Ans.43. Systematically
Unique
DEFINITIONS OF MANAGEMENT ACCOUNTING
The term “Management Accounting” covers all those services by which the
accounting department can assist the top management and other departments
in the formation of policy, control of execution and appreciation of
effectiveness. This definition points out that management is entrusted with the
primary task of planning, execution and control of the operating activities of an
enterprise. It constantly needs accounting information on which to base its
decision. A decision based on data is usually correct and the risk of erring is
minimized. Management accounting is concerned with the accumulation,
classification and interpretation of information that assists individual
executives to fulfil organizational objectives.
The Report of the Anglo-American Council of Productivity (1950) has also given
a definition of management accounting, which has been widely accepted.
According to it, "Management accounting is the presentation of accounting
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information in such a way as to assist the management in creation of policy
and the day to day operation of an undertaking".
An analysis of the above definition shows that management needs information
for better decision-making and effectiveness. The collection and presentation
of such information come within the area of management accounting. Thus,
accounting information should be recorded and presented in the form of
reports at such frequent intervals, as the management may want. These
reports present a systematic review of past events as well as an analytical
survey of current economic trends.
The usual approach is that, first of all, a thorough analysis of the whole
managerial process is made, and then the information required for each area is
explored, and finally, all the information, after analysis in terms of alternatives,
is taken into consideration before arriving at a management decision.
Q.44. Management is entrusted with the primary task of planning, execution
and control of the operating activities of an enterprise. (True)
Q.45. What is Management accounting?
Ans.45. Management accounting is concerned with the accumulation,
classification and interpretation of information that assists individual
executives to fulfil organizational objectives.
Q.46.Management does not need information for better decision-making and
effectiveness. (False)
Ans.46. Management needs information for better decision-making and
effectiveness.
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NATURE OF MANAGEMENT ACCOUNTING
The term management accounting is composed of ‘management’ and
'accounting'. The word ‘management’ here does not signify only the top
management but the entire personnel charged with the authority and
responsibility of operating an enterprise. The task of management accounting
involves furnishing accounting information to the management, which may
base its decisions on it.
It is through management accounting that the
management gets the tools for an analysis of its administrative action and can
lay suitable stress on the possible alternatives in terms of costs, prices and
profits, etc.
The word 'accounting' used in this phrase should not lead us to believe that it
is restricted to a mere record of business transactions i.e., book keeping only.
As it draws its raw material from several other disciplines like costing,
statistics, mathematics, financial accounting, etc., it can be called an
interdisciplinary subject.
The subject of management reveals the processes involved in the art of
managing, knowledge of Economics assists in the determination of optimum
output in the forecasting of sales and production, etc., and also makes it
possible to analyze management action in terms of cost revenues, profits,
growth, etc.
Management accounting has no set principles such as the double entry system
of bookkeeping. In place of generally accepted accounting principles, the
philosophy of cost benefit analysis is the core guide of this discipline. It says
that no accounting system is good or bad but is can be considered desirable so
long as it brings incremental benefits in excess of its incremental costs.
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Since management accounting is managerially oriented, its data is selective in
nature. It focuses on potential opportunities rather than opportunities lost.
The data is operative in nature catering to the operational needs of a firm. It
details events, monetary and non-monetary.
Management accounting is highly sensitive to management needs. However, it
assists the management and does not replace it. It represents a service phase
of management rather than a service to management from management
accountant. It is rather highly personalized service. Finally, it can be said that
the management accounting serves as a management information system and
so enables the management to manage better.
Q.47. What is the task of Management Accounting?
Ans.47. The task of management accounting involves furnishing accounting
information to the management, which may base its decisions on it.
Q.48. The term management accounting is composed of ‘management’ and
'accounting'. (True)
Q.49. The subject of management reveals the ___________involved in the art
of managing.
Ans.49. Processes
Q.50.Knowledge of ____________ assists in the determination of optimum
output in the forecasting of sales and production.
Ans.50. Economics
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Q.51. Management accounting has set principles such as the double entry
system of bookkeeping. (False)
Ans.51. Management accounting has no set principles such as the double entry
system of bookkeeping.
Q.52. Management accounting is highly sensitive to __________needs.
Ans.52. Management
Q.53. Management accounting serves as a management information system
and so enables the management to manage better. (True)
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